Nearly simultaneous bankruptcy filings last week by Delta Air Lines and Northwest Airlines marked a watershed moment for a chronically dysfunctional industry. Despite travel demand nearing peak levels of 2000, more than 40 percent of domestic industry capacity now is operated by insolvent companies. Seen as likely by many sources since Sept. 11, 2001, a shakeout in the commercial aviation sector appears underway.
Further along the restructuring spectrum, United Airlines this month finally filed a plan of reorganization and said it sees daylight after nearly three years of bankruptcy proceedings. US Airways similarly is planning to emerge from court protection, having all but wrapped up its merger with America West Airlines.
As those situations showed signs of progress—and provided glimpses into the industry's future—conditions at Delta and Northwest deteriorated, due in no small part to crippling jet fuel costs. Though both carriers for years have supported increasingly uncompetitive legacy cost structures, additional fuel price pressures in the wake of Hurricane Katrina was seen as the tipping point
(BTN, Sept. 5). Changes to bankruptcy laws set to take effect Oct. 17 also weighed heavily.
In the immediate term, both carriers committed to maintaining uninterrupted operations—including flight schedules, ticketing policies and frequent flyer programs—and corporate clients for now won't be significantly impacted. "Corporate customers are pretty numb to any announcements like this," said Dee Runyan, executive vice president at WorldTravel BTI.
Moving forward, however, many changes are expected within both carriers' networks, including the potential for a merger with one another.
Citing excess capacity, Northwest president and CEO Doug Steenland last week said, "it is reasonable to expect that consolidation could take place," but a merger involving Northwest had not been forwarded as part of the bankruptcy filing. When pressed further, Steenland said, "we do not comment or speculate" on potential transactions.
The fact that both cases were filed within minutes in U.S. Bankruptcy Court for the Southern District of New York was "completely coincidental," Steenland added. "It was not orchestrated." Even so, analysts suspected a merger was in the works. "We would not be surprised," said Helane Becker, analyst with The Benchmark Co. "In the past, these two airlines have talked, and they have very little route overlap."
Should consolidation take hold, it could "benefit pricing and capacity dynamics, though applying longer-term pressure on American and Continental," according to J.P. Morgan Securities analyst Jamie Baker.
Squared off against a combined Delta-Northwest entity, UAL and its stakeholders also could reassess United's competitive positioning. United contemplated such a scenario in a recent filing to the U.S. Department of Transportation, opposing SkyTeam alliance antitrust immunity
(see story)."Look at the synergies that US Airways and America West will start to get with their merger," said Runyan. "The others are looking toward that. Certainly they have been discussing it for years, but now, in some cases, it is probably more imminent."
One industry insider said the idea of a Delta-Northwest merger at the beginning of the decade would have been "impossible," owing to conflicting cultures. "Now, a lot of the people that made the Delta culture what it was are no longer there."
Before any potential consolidation, both carriers are expected to shrink, deploy regional jets on more routes and emphasize international networks.
"They will take a hard look at becoming truly low-cost, domestically," Runyan said. "Next year, these big carriers will be analyzing their routes to see what is viable, and tossing overboard those that aren't."
Such decisions undoubtedly would impact preferred corporate agreements covering affected routes, though longer-term ramifications are unclear. Sources suggested international purchasing strategies would be more tied to global airline alliances, especially if the U.S. government allows investment in U.S. carriers by foreign partners.
Meanwhile, in Delta's case, Judge Prudence Beatty ordered the airline to continue normal operations ahead of a first-day motion underway at press time.
The company said it has arranged a debtor-in-possession financing package backed by GE Commercial Finance and Morgan Stanley, with additional funding from American Express.
Delta also told customers that it would "utilize the Chapter 11 process as long as necessary to implement a successful plan of reorganization," a strategy not available to companies filing for bankruptcy after new rules take affect in October
(BTN, Aug. 16)."Delta's financial problems are severe, but by no means insurmountable,'' said CEO Gerald Grinstein.
The airline this year already eliminated its Dallas/Fort Worth hub and announced a 26 percent reduction at its Cincinnati hub. Further retreat is likely. "We expect little reduction by Delta in its overseas markets, whereas domestic capacity is expected to decline by a healthy 17 percent," said J.P. Morgan's Baker. He also suggested that Song operations "stick around" because "Song is pretty spiffy and customers like it, something that one doesn't hear—or, in fairness, hears far less often—regarding Big Delta."
Unlike Delta, Northwest intends to "expeditiously" complete the restructuring. "We certainly would not expect the process to come anywhere near the three-year process that has occurred at United," Steenland said.
Also unlike Delta, Northwest did not line up DIP financing ahead of its bankruptcy declaration. Steenland said the carrier believes it has sufficient cash to handle the restructuring, but also noted that "we are no longer an asset-rich company."
Meanwhile, Northwest has not yet specified capacity reductions beyond a previously announced suspension of New York JFK-Tokyo Narita service, which will eliminate 2 percent of its systemwide capacity.
"We clearly anticipate returning aircraft to our lessors and operating a somewhat smaller airline," Steenland said. "In the weeks ahead, that will be an element of our restructuring that will get a particular focus." He did not provide any guidance beyond saying, "if anything, frequencies might be somewhat less."
Steenland also stressed that an ongoing strike by the Aircraft Mechanics Fraternal Association did not prompt the filing nor does it complicate it, as the company and the union currently have no collective bargaining agreement in place. Northwest continues to use replacement workers.
Delta and Northwest also are pursuing federal pension relief. "Another first step could be some type of subsidy," predicted one travel management source. "Assistance could come in the areas of taxation and fees levied by federal, state and local government."
Meanwhile, Baker named "AirTran as the greatest beneficiary" of a Delta decline, particularly in Florida and on other hotly contested routes.
AirTran also could gain from an Independence Air shutdown. The Dulles, Va.-based low-fare carrier is expected to run out of cash soon and either seek bankruptcy protection or liquidate. The carrier already has scaled back transcontinental operations.
United Airlines also would benefit should Independence Air continue to reduce Dulles services. Such a development could ease UAL's emergence from bankruptcy protection, now set for Feb. 1.
When it exits court, the airline will have a leaner cost structure, revised agreements with United Express carriers, a revamped corporate sales organization and enhanced premium products. Financial projections filed in bankruptcy court show 2007 net income of $510 million, with results improving each year through 2010, when the company expects to net nearly $1 billion.
"We are now competitive with leading network carriers," said chairman and CEO Glenn Tilton.
Some industry observers, however, did not agree with such optimistic assessments. "The plan is not so much a projection of how the future will unfold as a prayer for everything to go right for the next four years," according to Roach and Sbarra, a San Francisco area airline consultancy. "Notably, the plan purports to evaluate various scenarios—such as future fuel and passenger ticket prices—and chooses the most optimistic projection for each as a 'conservative' basis on which to build its recovery plan."
Roach and Sbarra said UAL has "no provision for replacement, much less expansion, of United's aging fleet" and questioned how load factors would increase annually from current historically high levels. They also said UAL would face fiercer competition in international markets than the plan contemplates.
Given the volatility of the domestic market, however, United is relying on higher-yielding international routes and deeper ties with Star Alliance partners, including development of new technology platform
(see story), joint distribution strategies and expanded codesharing.
The airline plans to field "a stable fleet of 453 mainline aircraft" and 300 regional jets and turboprops owned by United Express carriers. Combined operations would generate slightly more available seat miles in 2006, and remain flat through 2010. Fuel costs are projected to decline through 2009; $150 million per year is earmarked for fuel hedges, starting in 2007, "to lock in as much of its fuel needs at $50 per barrel as possible."
The bankruptcy court scheduled a hearing for Oct. 11 to assess the adequacy of UAL's disclosure statement. Should the court approve, the company then would solicit votes for confirmation of the reorganization plan. Approval from UAL's creditors committee, however, is by no a means a slam dunk, especially in light of last week's developments.
"The final chapter on the UAL story certainly has yet to be written," said one insider.
For its part, US Airways last week took more steps toward its next incarnation when its creditors and America West Airlines shareholders voted to approve the merger of the two carriers. A bankruptcy court hearing on US Airways' reorganization plan was underway at press time last week. Both carriers still expect to cement the merger by the end of this month.